Sovereign Debt – Towards More Complex and Costly Capital Structures?

The simplicity of sovereign capital structure is eroding, and the central question raised in Lazard's latest Policy Paper is whether it is changing for the better. Our Sovereign Advisory team argues that it is not, unless the changes are actively governed.

The liability side of a sovereign’s balance sheet has historically been simple, certainly as compared to banks and, to a large extent, corporates. This is changing, especially for emerging and frontier-market economies. Their capital structures are becoming increasingly complex because of an intricate and largely implicit hierarchy of claims, and because of the proliferation of contingent instruments that generally make their debt less predictable. 

Two consequences are likely. First, a future impact on the overall cost of debt: absent clarity on the hierarchy of claims, which inevitably increases the loss given default for the least-senior creditor, and unless the shock-absorptive virtue of contingent instruments outweighs their complexity and unpredictability, the odds are that countries will pay a complexity/uncertainty premium. Second, an impact on markets’ efficiency and restructuring feasibility: an unmapped, uncertain liability stack is one the IMF cannot properly analyze, one the markets cannot price, and one that a debtor and a creditors’ committee cannot restructure without years of delay. The policy response is not to resist diversification but to discipline it, promoting the contingent and transparent forms while containing the opaque and subordinating ones.